The annual World Economic Forum gathering of business and political leaders, held in the Swiss alpine resort of Davos last week, spent a lot of time discussing ‘de-globalisation.’ Is the world becoming more insular and multipolar as economies cope with post-pandemic supply chain disruptions, inflationary shortages, China’s zero-Covid strategy and war in Ukraine? We believe that the process of globalisation will evolve rather than come to a halt.
If we think of globalisation as a process of supporting continuous growth and higher living standards, then it might be argued that we are experiencing a period of de-globalisation. Faced with political nationalism, hundreds of western companies exiting the Russian market, a lack of high profile new trade agreements, and the continuing US and Chinese tit-for-tat tariffs, it is tempting to see globalisation going in reverse.
We have been here before. The term ‘de-globalisation’ first appeared in the aftermath of the Great Financial Crisis and was seen as a function of slowing global growth. But globalisation did not start with the invention of the shipping container in the 1950s, the end of the Cold war, or China’s accession to the World Trade Organisation (WTO) in 2001. It is has been a process of evolution for centuries, and arguably will not end because of the pandemic, China’s latest Covid measures, nor the war in Ukraine.
The network of raw materials, manufacturing, distribution and delivery that, until the pandemic, we took for granted has come under scrutiny as it ran into shortages of labour and components. A lack of masks, then competing national vaccine procurement, all underlined our dependence on imports and sourcing goods worldwide and the need to move them across borders with minimal delays. Manufacturing that has developed ‘just-in-time’ systems in recent decades is shifting to ‘just-in-case’ production to beat supply chain disruptions.
As New York Times columnist Thomas L. Friedman argued at Davos last week, globalisation is not a one-way process. The last 14 years have shown that it is not only economic and geopolitical, but is also driven by consumers and their ability to communicate worldwide, compare experiences across borders and regions and so drive demand. Viewed in that light, globalisation includes the ways in which trade and technologies are making the world more connected and interdependent. In this context then, we can think of globalisation as evolving rather than ending.
Of course, the world is becoming more multipolar, and may begin to coalesce around like-minded trading partners in a process sometimes labelled ‘friend-shoring.’ The most obvious emerging bloc may be the US and European Union and their allies who have rapidly implemented a series of sanctions against Russia. Equally obvious is a non-aligned group, including Brazil, India, South Africa and China who remain unwilling, or unable, to sever ties with Russia. In the longer term, the single most important bilateral relationship remains the competition between the US and China.
The era of ambitious multilateral agreements facilitating trade at the global and regional level looks to belong to the past. The General Agreement on Tariffs and Trade (GATT) dates from 1947, ASEAN (1961), Mercosur (1991 and 1994), NAFTA (1992), and the WTO (1995). In some cases, this network of trade accords is being overhauled or dismantled; the UK voted for Brexit in 2016, the Trump administration removed the US from the Trans-Pacific Partnership (TPP) in 2017, renegotiated a deal with Mexico and Canada in 2018 and has blocked the WTO’s dispute system since December 2019. However, last week the Biden administration signed a 13-nation Indo-Pacific Economic Framework that includes labour standards and e-commerce provisions but like the TPP before it, excludes China.
Before the current inflation crisis, covid’s labour scarcities and disrupted consumer demand created a shortage of shipping containers. Prices rose from around USD 1,500 in February 2020 to peak at more than USD 10,300 in September 2021. Container costs are still far higher than before the pandemic, at USD 7,768 in April.
That has not prevented the value of trade increasing. Since the invention of the 20-foot (6.1 metre) long standardised steel shipping container in 1956, world trade volumes have increased 40 times, according to the World Trade Organisation, and the value of merchandised moved is nearly 300 times greater. In 2021, the total value of goods trade reached a record of USD 28.5 trillion, a 25% increase on 2020, and a 13% rise compared with 2019. Trade in services reached USD 1.6 trillion in 2021, similar to 2019’s levels. Nevertheless, the pace of global trade growth has been slowing since the Great Financial Crisis. Where it expanded by 6% a year on average after 1945, it slowed to around 3% annually since 2008, and we expect it to slow to around 1.5% going forward (see chart 1).
From ‘just-in-time’ to ‘just-in-case’
Any chain, the saying goes, is only as strong as its weakest link. Just as the world is becoming more multipolar, so industrial supply chains are adapting to insulate themselves from disruptions. This is turning a pre-pandemic preoccupation with costs to a focus on sourcing and production resilience.
One way of improving resilience may be a corporate shift to ‘dual sourcing’ components and manufacturing, building the same elements in two or more locations, and so creating some overlapping redundancy. This trend can be summarised as a move away from ‘just-in-time’ to ‘just-in-case’ manufacturing. The price for greater procurement resilience will be the costs associated with smaller production volumes and potentially higher wages.
Discussions around national-focused ‘on-shoring’ are being replaced by ‘near-shoring’ or relocating production to within friendly nations. We should not overstate this trend however. If relocation is happening, it is doing so in the background, while many large corporations such as European aircraft maker Airbus, for example, continue to increase manufacturing capacity in China.
Given its strategic importance to electronics, one sector that may move production locations is the semiconductor industry. China accounts for around one quarter of the world’s semiconductor exports, Japan and Taiwan together produce another fifth. However, any shift in manufacturing location cannot happen quickly as new ‘fabrication’ facilities can take three years from commissioning to delivering product.
Semiconductor chip shortages have impacted on the car industry, slowing deliveries, driving up the prices of second-hand vehicles and costing as much as an estimated 10% of the global sales in 2021. In Europe, that effect on car production is likely to intensify with another 5% cut in volumes in 2022 expectations because of the war in Ukraine, where much of the automotive industry’s wiring is assembled. Longer term, carmakers will have to continue assembly in lower-cost economies, such as Ukraine, China, Mexico and in North African nations, even if the current disruptions continue. At the other end of the price spectrum, some industry sectors such as fashion are highly commoditised with very little room for price rises, and so no margin for redirecting production locally.
Globalisation is evolving as trade adapts to changing geopolitical constraints to meet consumer demand. As it does so, we do not anticipate major structural implications for either inflation or economic growth because goods find their way to these consumers, even in the face of higher trade barriers.
For example, China’s share of world exports has risen, as its volume of direct exports to the US has declined since 2018 when the two countries began to escalate tariffs on one another’s imports (see chart 2). Higher US/China trade tariffs triggered a shift to production in near or neighbouring locations such as Vietnam, rather than a radical move to ‘onshore’ production.
While tariffs are never beneficial for an economy, their impact looks relatively limited. The duties imposed by the previous US administration are estimated to shave 0.2% from America’s gross domestic product growth over the long term. Perhaps more importantly in the shorter term fight against rising consumer prices, we estimate that a complete reversal of the tariffs would cut US headline inflation by around 1.3%.
A shift to more regional trading blocs may also eventually challenge the US dollar’s role as the world’s reserve currency. However, the need to trade globally and the US consumer’s purchasing power have driven the dollar’s status and will continue to do so. As we discussed in a recent article, there are few alternatives, making it difficult to see the dollar losing its position as the world’s dominant currency.
Re-thinking sectoral investments
The corporate reality for most industries is that they operate in globally integrated markets that stretch from procurement and production to sales. As a result, companies in a specific sector may have more in common with one another than companies in a particular country or regional index. However, there is evidence that a dispersion of returns is at least as important for stocks within sectors and regions (see chart 3 and 4). Therefore, in looking for investment opportunities, investors should complement tactical regional views with thematic, as well as sector views.